Best & Worst ETFs & Mutual Funds: Telecom Services Sector

The Telecom Services sector ranks ninth out of the ten sectors as detailed in my sector roadmap. It gets my Dangerous rating, which is based on aggregation of ratings of 5 ETFs and 12 mutual funds in the Telecom sector as of April 17, 2012.

Figure 1 ranks all five Telecom Services ETFs from best to worst. Figure 2 shows the five best and worst-rated Telecom Services mutual funds.

Telecom sector investors should use a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings.

The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.

Investors should not buy any Telecom ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.

Figure 1: ETFs Ranked From Best To Worst

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings - Top 5

* Best mutual funds exclude funds with TNA's less than 100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Guggenheim Investments Telecommunications Fund (MUTF:RYMIX) is excluded from Figure 2 because its total net assets (NYSEARCA:TNA) are below $100 million and do not meet our liquidity standards.

Figure 3 shows that only 14 out of the 96 stocks (87% of the total net assets) held by Telecom ETFs and mutual funds get an Attractive-or-better rating. This explains why none of the 5 ETFs and 12 mutual funds earn an Attractive-or-better rating. Figure 3 supports my message that the quality of any ETF and mutual fund is determined by the quality of the stocks it holds.

Investors should not buy any Telecom ETFs or mutual funds, as all of the ETFs and 11 of the 12 mutual funds earn a Dangerous-or-worse rating. Instead, they should focus on individual holdings.

For example, Neutral Tandem (NASDAQ:IQNT) is one of my favorite stocks held by Telecom ETFs and mutual funds. It earns my Attractive rating. The Telecom Services sector doesn't have much to offer when it comes to attractive stock investments but IQNT is a diamond in the rough. Like stocks on my Most Attractive list, IQNT has a cheap valuation. The current stock price (~11.86) implies the company's profits will permanently decline by 10%. The no growth value of the business is $13.41/share or 13% above the current stock price. Good risk/reward.

Leap Wireless International Inc. (LEAP) is one of my least favorite stocks held by Telecom ETFs and mutual funds. It earns my Very Dangerous rating. Unlike IQNT, LEAP offers a poor risk/reward tradeoff. LEAP's current stock price (~$8.22) requires the company to grow its profits by 8% compounded annually for 36 years. This seems highly unlikely given that the company has averaged -3% growth over the past 3 years. Another reason to avoid LEAP is its inability to generate a return on invested capital in excess of its weighted average cost of capital.

43 stocks of the 3000+ I cover are classified as Telecom stocks, but due to style drift, Telecom ETFs and mutual funds hold 96 stocks.

Figures 4 and 5 show the rating landscape of all Telecom ETFs and mutual funds.

Figure 4: Separating the Best ETFs From the Worst ETFs

Click to enlarge

Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds

Click to enlarge

Sources: New Constructs, LLC and company filings

Disclosure: I receive no compensation to write about any specific stock, sector or theme.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.